Fed Can't Twist Sell Signals Away

The Wall Street Journal's cover story on September 8 boldly proclaimed "Fed
Prepares to Act". The article hinted that 'Operation Twist' may be in
the works (more on that below). Can you imagine the market's reaction to
a headline like that in the late 1990s when the Fed was looked at as some
kind of miracle worker? The S&P 500 futures would have popped in the
morning and inflation-protection assets would have had a strong open. On
the morning of said Wall Street Journal article, the markets barely took
notice of possible Fed action. This is clear evidence the markets no longer
place central bankers on the miracle worker's pedestal. It also shows fear
of debt-induced deflationary outcomes is now outweighing the fear of inflation.
These are significant and dangerous shifts for the market's risk/reward profile.
If this shift continues, stocks (SPY) and commodities (DBC) may experience
further, and rapid declines in the next six months, if not much sooner. We
added to our short positions (SH) on August 8.

From a technical perspective, every long-term sell signal we outlined in this
September 5 video remains
in place. If you have capital at risk in the markets, it is well worth your
time to review these clear and observable signals that are similar to those
that were in place in 2000 and early 2008. As noted in the excerpts from a
recent Bloomberg article
below, policymakers are using standard recession fighting tools in the present
day; tools which are not appropriate for the long-term structural problems
we face.

"The key issue any risk manager faces today is that too many parameters
have become variables," El-Erian said. "A cyclical mindset is not sufficient
given the world we live in," he said. " You need to think structurally."

If you are hoping the Fed will ride to the rescue on the 'Operation Twist'
horse, you may be disappointed. In October
2010, we postulated the Fed's second quantitative easing program (QE2)
was designed to inflate asset prices, which is exactly what it did (temporarily).
QE2 flooded the financial system with freshly printed U.S. dollars - it was
pure money printing, which increased the money supply. 'Operation Twist', where
the Fed sells short-maturity bonds and uses the proceeds to buy longer maturity
bonds, will not increase the amount of dollars in the financial system, which
is a stark contrast to QE2. 'Operation Twist' is like shuffling your bond portfolio
on the deck of the economic Titanic; it points to a Fed that is running out
of options, especially politically correct options, to stimulate the economy.
We noted on August
19 that QE2 winners (silver (SLV), energy stocks (XLE), etc.) are not forecasting
a miracle stick save form the Fed; nothing has changed in the price/volume
action of those assets to change our stance.

As of the close on August 8, the S&P 500's recent rally looks like a typical
retracement rally, or bear market rally within a downtrend. Traders watch retracement
levels which stood at 1,231 and 1,204 (see orange and purple text below).

A recent Bloomberg story should
be a wake-up call for all of us to take the problems in Europe very seriously:

Credit-default swaps on Greek government debt surged to a record, signaling
a 91 percent chance the nation will fail to meet debt commitments, after
its economy shrank more than previously reported.

"It's a combination of Greece continuing to disappoint and probably a
growing realization among politicians that they're throwing good money
after bad," said Gary Jenkins, head of fixed income at Evolution Securities
Ltd. in London. "They've finally woken up to the fact that they're not
going to get this money back."

A clear break of short-term retracement levels, shown below at 1,186 (point
B below) and 1,177 (point C) on the S&P 500, would be another short-term
red flag for asset prices.

We will remain defensive/bearish until we see improvement in the fundamentals
(mainly Europe) and the technicals. Keeping an open mind about a possible change
in the market's tone is always a good idea.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

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